Dividends – Where Do You Include Them In Your Asset Allocation?
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Aaaahhhh the good old topic of asset allocation. As a financial planner, I work continually with my clients to optimize their asset allocation so they maximize their return and minimize their risk. Investing is good, diversifying is great, but optimizing your investments through a solid asset allocation and diversification with the right solutions is the best. However, it has become a bit harder to determine your asset allocation when it comes to dividends – where do you include them in your asset allocation?
Classic Asset Allocation Model
If you take a classic asset allocation model, you will have 2 types of assets (I know, this is very basic):
Asset class A: Fixed income
Asset class B: Equities
Fixed income is pretty easy to define when you look at bonds and certificates of deposit: they all pay a steady interest income.
If you look at Equities, you get a simple definition as well: they are shares issued by public companies.
So where do you put a share of a public company paying steady dividends?
Dividend stocks are sitting comfortably on the line between fixed income (since they are paying a steady income) and equities (as shares will benefit from capital growth).
Therefore, one can easily say that he picks “secure” dividend payers (such as dividend aristocrats or dividend achievers) and puts his dividend holdings into the fixed income portion. On the other hand, someone else could say that he manages a portfolio of stocks, that are paying dividends as a bonus) and puts his holdings in the equity section. But do they know the volatility and risk factors attached to their portfolio?
Where the line becomes even more gray
It’s even worse when you look at mutual funds. Since most dividend funds also include a bonds in their portfolio, they can be included in fixed income. However, I’m sure that you will agree with me that if someone is looking for a highly secure portfolio (90%+ in fixed income), dividend funds might not be the right solution for him. I’m not sure that retirees should blindly follow their financial advisors and invest massively into dividend funds without knowing the difference in fluctuation between a bond fund and a dividend fund.
I know, the bond fund can also lose value if interest rates climb suddenly. However, I don’t think bond funds in general will fluctuate as much as dividend funds.
Dividend stocks should be considered as a balanced investment
Because of their double nature, I would be tempted to say that my dividend holdings represent an investment at 50% in fixed income and 50% in equities. Dividend paying stocks are usually less volatile than non dividend paying stocks and they generate a steady cash flow for the shareholder. On the other hand, shares will also appreciate upon good news on the market. This is why I think it should be considered as a balanced investment.
In fact, if you want to have a “safer” or a “more aggressive” dividend portfolio, you can manage your asset allocation per investing sector:
Basic Materials
Communications
Consumer, Cyclical
Consumer, non-Cyclical
Energy
Financial
Industrial
Technology
Utilities
For example, if you concentrate more on utilities, you should have a “safer” portfolio as several utility companies are paying about the same dividend payout ratio and are very stable in their payments. Whereas consumer cyclicals can experience a lot more growth during an economic recovery.
As for me, I am not buying bonds right now because I think dividend stocks are better than bonds. Therefore, I would rather have a “balanced” portfolio with dividend stocks than have 50% of my investments in bonds paying low interest 
. I have also preferred to add a little bit more growth in my portfolio with 4 stocks in the energy sector (VNP and PDN don’t pay dividends though) while keeping my shares of RIM at the moment. Hopefully the Playbook will put back RIM on the map so I can sell my shares with a good profit by the end of the year .
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10 Comments on this post
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Ravi Gupta said:
Good post! I think it all depends on how much risk someone is willing to take and how they want to trade. I’m personally a big fan of holding etfs since they will mean less work for me. I’m personally looking at a 50 / 50 porftolio of equities and fixed income with room to diversify further later on.
-Ravi Gupta
April 11th, 2011 at 7:00 am -
Michel said:
I agree, dividends over bonds, especially now…(rising interest rates, etc.)
April 11th, 2011 at 1:22 pm -
The Dividend Pig said:
Interesting, and I think you are correct in saying solid dividend paying stocks are a middle ground between equities and fixed income. I would also add higher yielding but slower growing options like REITS and MLPS, along with preferred shares, to your list.
As for the playbook, well, I think that’s a stretch.
April 11th, 2011 at 6:03 pm -
Mike said:
@ Dividend Pig,
yeah I know but I have already the position in RIM… I rather be optimistic
April 12th, 2011 at 12:30 pm -
Rikhi Raj Sachdev said:
I agree with your thoughts that dividend paying stocks great investments. In fact I think they are better than bonds because by investing in great companies that pay regular and increasing dividends I can grow my investments for the long term and I be able to leave a legacy for my future generations.
April 15th, 2011 at 10:10 pm -
Dividend Mantra said:
I am 100% allocated to dividend growth equities. I may eventually go long in fixed-income securities once interest rates rise, but for now I’m perfectly happy collecting my dividend checks and reinvesting selectively.
April 16th, 2011 at 7:13 pm
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